The U.S. Federal Reserve finally started raising rates after almost a decade. Many people were expecting the Fed to raise rates much earlier in 2015, but the central bank didn’t move until its December meeting.

Fed notes released following the announcement did not reveal many surprises, but there was one that caught our attention. The dot plot (interest rate targets suggested by individual Fed governors) revealed that most Fed officials believed rates could go up another four times in 2016. This is quite aggressive in our minds, and something that most market participants may not have expected. So, though the uncertainty around the timing of the first rate hike is now over, the uncertainty surrounding the number and magnitude of future rate hikes is just starting.

After seeing a difficult third quarter, most global equity markets rebounded to post positive returns in Q4, led by the U.S. (see Chart 1). Despite the Q4 rally, the S&P 500 finished the year up just 1.4% on a total return basis in U.S. dollars, while losing 0.7% on a price basis – its first loss since 2008.

Equity markets in Q4

Source: Bloomberg

While positive economic data continues to support U.S. markets, the Canadian economy continues to show weakness as oil dropped even further, breaking through US$35 a barrel during Q4 before ending the quarter slightly higher (see Chart 2). This has caused the Canadian equity market to be one of the few to post a negative return, with the S&P/TSX Composite Index dropping 1.4% in Q4 to finish the year down 8.3% including dividends.

Oil price plunge continues

Source: Bloomberg

Surprisingly, not much noise came out of international markets in Q4. The European Central Bank did lower rates and extended its quantitative easing program (though it did not change the size). We feel both initiatives are positives for the eurozone economy.

Investors believe this to be a sign that continued support will be there for this market. As a result, the MSCI EAFE Index ended the period with a gain of 4.8% in U.S. dollar terms. The Euro STOXX 50 Index rose 5.8% in local currency. The MSCI Emerging Markets Index also ended the quarter up 0.5% in U.S. dollar terms. In local currency terms, Chinese mainland stocks bounced back with a return of 16.5%, while India was flat for the period.

North American bond yields remained low during Q4, with the Fed rate hike pretty much priced in.

Canadian bond yields remain low

In Q4 we continued to see low bond yields – a trend that we expect to persist in 2016. This was a result of weak GDP numbers, an ongoing drop in oil prices and the continued belief that the Canadian economy is struggling.

With the Fed starting to raise rates, we may finally have the catalyst to see U.S. bond yields rise. Canadian bond yields on the other hand may not appreciate as fast, given that we see no rate hike on the horizon and a rate cut remains a good possibility. We expect negative bond returns in the U.S. and relatively flat returns for Canadian bonds in 2016.

Interestingly, the U.S. 10-year Treasury yield was up 10 bps for the year, while the Canadian 10-year government bond yield was down 40 bps.

No relief for Canadian equities

The story remains the same in Canada. As in recent quarters, slumping commodity and oil prices continue to take a toll on the economy. At the time of writing, West Texas Intermediate crude was sitting at about US$36 a barrel, and though we may see prices rise in 2016, low oil prices are something that energy companies now need to deal with. The S&P/TSX energy sector had a decent quarter but plunged 21.0% in 2015. The materials sector actually did worse, down 24.2%. (see Chart 3).

Resource sectors continue to be punished

Source: Bloomberg

It should be noted that despite seeing the Canadian dollar drop to its lowest level in almost 12 years, the manufacturing sector has not really seen much improvement. We doubt that we will see much growth in this area unless the Canadian dollar falls to around US$0.60 cents–something that we are not predicting even in our most bearish scenarios.

With a new government in place we should see some additional spending on infrastructure. This should stimulate employment and help offset additional job losses in the energy sector. We could also see another rate cut from the Bank of Canada if oil prices continue to remain at these low levels.

Though we still see more pain in Canadian equities there may finally be some opportunities, particularly in the energy sector, given current price levels. But, as with most things, patience is the key.

U.S. equity market looking more risky

The U.S. equity market rebounded strongly in Q4, supported by decent economic data. Employment also improved, but at a slightly slower pace than at the beginning of the year. The Fed has started to raise rates which should start to slow growth. How much it slows depends on what happens with rates this year.

The U.S. dollar continues to be quite strong against most major currencies and this should also dampen growth in the export sector. That said, U.S. consumers remain strong and low oil prices will continue to stimulate spending. Housing still looks to be a positive in 2016 as supply is still relatively low and home prices remain affordable.

As predicted, we expected the U.S. equity market to bounce back, but not to hit another new high in Q4. And that looks to be our view in 2016 as well. We expect the U.S. equity market to have a positive year, but nothing to brag about as we continue to see the risk/reward tradeoff deteriorate.

Progress in the eurozone

We feel the eurozone economy continues to head in the right direction and we are pleased with the progress there. Each quarter we are seeing more jobs being created with the unemployment rate decreasing. There was no major noise out of Greece but it’s likely just a matter of time before that changes. However, we feel the impact of anything on that front will do minimal damage to the markets.

We think that even more monetary stimulus will be in the cards for the eurozone in 2016, along with a weaker currency, and that makes us optimistic about investing in international equity markets. One important thing to watch for will be political change within the Eurozone, which may cause some disruptions.

Emerging markets somewhat quiet

It was nice to see no major news out of China this quarter and we actually saw an equity rally. But just when we thought the market may have finally embraced China’s lower-growth profile, we saw another major decline on the first day of trading in 2016. As such, we could see additional volatility in 2016. India continues to impress us and we think the equity market will deliver another positive result next year.

Emerging markets is an asset class that could see a bumpy ride as the divergence among economies is quite prevalent, and a strong U.S. dollar is likely to be an ongoing headwind. Expert country and stock selection will be very important in this asset class in 2016.

Outlook: Mixed results ahead

Though volatility decreased in Q4 we expect it to pick up again this year. We still feel there is a fair bit of nervousness out there, which could cause markets to have more of a rollercoaster ride.

Our view has not changed about the U.S. economy, but when it comes to the S&P 500 we think returns are likely to be modest at best. We have grown more cautious since the market rebounded in Q4.

Things continue to play out as we expected in the eurozone. We see slightly more stimulus, and as long as quantitative easing continues and the euro remains weak we expect positive results out of the markets. We expect a lot more political noise in 2016, which may lead to opportunities if the markets pull back. This is a longer-term investment for us and our confidence in this market is increasing.

In our home country however, all is not well. Though we raised our short-term view in Q4, we have since taken it back down. The continuing fall in oil prices will likely hit energy companies even harder than expected, and we feel more jobs losses are on the way. We do think the energy sector is looking more attractive given current price levels, but we are not buyers at this time.

The Canadian dollar sank during the quarter, ending at around US$0.72. We don’t expect the Canadian dollar to break 70 cents, but that will depend on how aggressive the Fed is with its rate hikes and whether the Bank of Canada cuts again.

We expect bond yields to start their upward trajectory now that the Fed has started raising rates, causing negative returns for bonds – more so for global bonds than Canadian bonds. That being said, we see Canadian bonds getting a potential lift if the Bank of Canada does indeed cut rates.

Overall, we feel that volatility will be more predominant in 2016 and that further upside in most equity and bond markets may be limited. This will be a year when thoughtful asset allocation will be vital, as there will likely be more divergence among markets. We continue to take a conservative approach and will happily wait for opportunities.

This commentary contains information in summary form, for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.